Weak starting point for next year’s threats to the economy

It’s clear the economy’s started slowing, with the strong bounceback from the lockdowns nearing its end. That’s before we’ve felt much drag from the big rise in interest rates. Or the bigger economies pulling us lower, which is in store for next year.

To be sure, the economy’s closer to full employment than we’ve been half a century. But limiting the decline from here on will be a tricky task for Anthony Albanese and, more particularly, Reserve Bank governor Philip Lowe.

The Australian Bureau of Statistics’ “national accounts” for the three months to the end of September, published this week, showed real gross domestic product – the nation’s total production of goods and services – growing by just 0.6 per cent during the quarter, and by 5.9 per cent over the year to September.

Focus on the 0.6 per cent, not the 5.9 per cent – it’s ancient history. Most of it comes from huge growth of 3.8 per cent in the December quarter of last year, which was the biggest part of the bounceback following the end of the second lockdown of NSW, the ACT and Victoria.

Since then, we’ve had quarterly growth of 0.4 per cent, 0.9 per cent and now 0.6 per cent. That’s the slowing. Quarterly growth of 0.6 per cent equals annualised growth of about 2.5 per cent. That’s about the speed the economy was growing at before the pandemic, which we knew was on the weak side.

Dig deeper into the figures, and you see more evidence of slowing. Strong spending by consumers was pretty much the only thing keeping the economy expanding last quarter. Consumption grew by a seemingly healthy 1.1 per cent, which accounted for all the growth in GDP overall of 0.6 per cent. The various other potential contributors to growth – business investment spending, new home building, exports and so forth – cancelled each other out.

But get this: that growth of 1.1 per cent was half what it was in the previous quarter. And what were the main categories of strong spending by consumers? Spending in hotels, cafes and restaurants was up by 5.5 per cent in the quarter.

Spending on “transport services” – mainly domestic and overseas travel – was up almost 14 per cent. And purchase of cars was up 10 per cent.

Anything strike you about that list? It’s consumers still catching up after the end of the lockdowns, when most people were still earning income, but were prevented from spending it. We couldn’t go out to hotels, cafes and restaurants, interstate travel was restricted, and overseas holidays were verboten.

As for buying a new car, an earlier global shortage of silicon chips and container shipping mean few were coming into the country.

Get it? Much of the strong consumer spending that kept the economy moving last quarter was driven by life getting back to normal after the lockdowns and the easing of pandemic-caused supply shortages. It’s a temporary catch-up, that won’t continue for long.

Now let’s look at what the quarterly accounts tell us about the state of households’ finances. Despite their strong consumer spending, their real disposable income actually fell a fraction during the quarter, taking the total fall over the year to September to 2.6 per cent.

Why did households’ income fall? Because prices rose faster than wages did. How did households increase their spending while their income was falling? By cutting the proportion of their incomes they’d been saving rather than spending.

After the first lockdown in 2020, the household saving rate leapt to more than 19 per cent of disposable income. Why? Because people had lots of income they simply couldn’t spend.

But the rate of saving has fallen sharply since then. And in the September quarter it fell from 8.3 per cent of income to 6.9 per cent – almost back to where it was before the pandemic.

As Callam Pickering, of the Indeed jobs site, explains, “households have been relying on their savings, accrued during the pandemic, to maintain their spending in recent quarters”. Lately, however, they’ve “been hit from all angles, with high inflation, falling [house] prices and mortgage repayments all weighing heavily on household budgets”.

“As household saving continues to ease, the ability of households to absorb the impact of higher prices and rising interest rates will also diminish,” he says.

By the end of September, the hit from higher interest rates was just getting started. Of the 3 percentage-point increase in the official interest rate we know has happened, only 0.75 percentage points had yet reached home borrowers.

So, the hit to growth from government monetary policy is only starting. As for the other policy arm, fiscal policy, we know from the October budget it won’t be helping push the economy along. And in the September quarter, falling spending on infrastructure caused total public sector spending to subtract a little from overall growth in GDP.

A similar subtraction came from net exports. Although the volume of exports rose by 2.7 per cent during the quarter, the volume of imports rose by more – 3.9 per cent. A big part of this net subtraction came from the reopening of our international borders. Our earnings from incoming travellers rose by 18.6 per cent, whereas the cost of our own overseas travel jumped by 58 per cent.

Finally, self-righteous business people are always telling us that if we want to real wages to rise rather than fall, there’s an obvious answer: we’ll have to raise our productivity.

Sorry, not so simple, preacher-man. The accounts show that real labour costs to employers per unit of output fell by 2.6 per cent over the year to September.

Meaning that after allowing for the productivity improvement the nation’s employers gained, the increase in wages and other labour costs were a lot less than the increase in the prices they charged.

This suggests business profits are much better placed to weather next year’s hard times than their workers’ and customers’ pockets are. Not a good omen.

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Both sides exaggerate significance of wage bargaining changes

Do you realise, in just the six months it’s been in office, the Albanese government has passed 61 bills, covering most of what it promised to do at the May election?

Just last week it passed the National Anti-Corruption Commission Bill and the controversial Secure Jobs, Better Pay bill. According to Anthony Albanese, the latter involved “the biggest workplace reforms since the 1970s” and its passing made last Friday “a huge day for working Australians”.

Sorry, this government’s degree of effort and expedition far exceeds anything achieved by its predecessor and some of its measures are truly memorable, but its industrial relations changes are nothing like that monumental.

For one thing, Albanese has yet to act on his promises to regulate the gig economy, act decisively to reduce wage theft and reduce the use of casuals and labour-hire companies.

But it’s not just Albanese who’s been laying it on too thick. Indeed, the prize for the biggest storm-in-a-teacup of the year must surely go to the Secure Jobs, Better Pay bill. Its passing was certainly “controversial” – the enormous fuss made by the various employer groups made sure of that – but the degree of controversy generated is an unreliable guide to the likely threat – or promise – from the changes made.

Two fearless predictions. First, the changes won’t be nearly as bad as the lobbyists’ scaremongering claimed. But equally, they won’t have nearly as much effect on the jobs and pay of “working Australians” as the government wants us to believe.

The employer groups’ repeated claims that the government’s efforts to increase the scope for “multi-employer bargaining” would lead to widespread strikes and job losses seems intended to bamboozle those not old enough to remember industrial relations when they really were red in tooth and claw.

Strike action peaked in the 1970s, when the number of strikes averaged 2370 a year, with total days of work lost averaging 3.1 million a year, and days lost per 1000 workers averaging 540. As in all the rich countries, strike action has declined markedly since then, with the 2010s seeing only 200 strikes per year, costing 145,000 days lost, or 14 days per 1000 workers.

The notion that Albanese’s modest changes will return us to anything remotely approaching the 1970s is risible.

In those days, when inflation was far higher than it is now, our long-gone system of compulsory arbitration had the perverse effect of encouraging many quite short strikes. These days, old IR hands know that if a strike lasts more than a day or two it’s a sign the union has lost. It will then take years for whatever small pay rise the workers end up getting to make up for the many days’ pay they lost.

Ask yourself this: how are widespread strikes supposed to lead directly to widespread job losses? They don’t. They lead to some workers losing their jobs only because the majority who don’t lose their jobs are getting wage rises so big that employers genuinely can’t afford them. It’s not a reasoned argument, it’s an attempt to frighten the unthinking.

What employers really fear is a move from bargaining at the level of the individual business or enterprise to bargaining at an industry-wide level, which would make it easier for the unions to achieve pay rises in businesses with few union members.

Although industry-wide bargaining remains outlawed by the Fair Work Act, the employer groups have chosen to pretend that the government’s cautious extension of access to multi-enterprise bargaining is pretty much the same thing.

Nonsense. As Adelaide University’s Professor Andrew Stewart explains, the new provision for “single- (or common-) interest” multi-employer bargaining is hedged about with limitations and protections. Unions will not be able to rope in small businesses employing fewer than 20 workers. Larger employers can only be included without their consent if a majority of their workers wants to bargain.

Access to this form of bargaining must be approved by the Fair Work Commission, which will permit employers to participate only if they are sufficiently “comparable” to the other employers. An employer with an existing single-enterprise agreement won’t be able to switch to a multi-employer agreement.

But those employers included in such bargaining will be required to bargain in “good faith” – be genuinely committed to reaching an agreement, and unions will be permitted to strike – provided this is approved by a secret ballot of employees.

A significant change is that, when either single- or multi-enterprise bargaining becomes intractable, the commission will resolve the dispute by arbitration.

The other new provision for “supported bargaining” of multi-employer agreements is aimed at helping low-paid workers in strongly female industries such as childcare and aged care. This is likely to produce some significant pay rises. Why? Because the “support” will come from the third party that will end up covering the cost of the pay rise – the federal government.

Apart from that, the low union membership in most of the relevant enterprises says there’ll be few strikes and few big pay rises.

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Treasury's advice now back in favour with the government

The Coalition’s practice of sacking a bunch of government department heads whenever it gets back to office is clearly calculated to discourage bureaucrats from giving frank advice. Fortunately for us, the Albanese government is not as arrogant.

In my experience, weak managers surround themselves with yes-persons, so their brains – and, as they see it, their authority – aren’t challenged.

Strong managers want frank advice from their experts, so they’re less likely to stuff up. They’re confident of their ability to sift through conflicting advice and pick the best way forward.

This Liberal policy of frightening bureaucrats into keeping their opinions to themselves began when they returned to power in 1996 under John Howard. It was repeated when Tony Abbott got back in 2013, sacking then Treasury secretary Dr Martin Parkinson and various other Treasury-related department heads (narrowly missing Treasury’s incumbent, Dr Steven Kennedy).

Their crime, it seemed, was that they actually believed in the Rudd-Gillard government’s policy of using an emissions trading scheme to limit carbon emissions. Guilty as charged. Like almost all economists, Treasury accepted the scientists’ advice on the science, and believed the best tools for fighting climate change were economic instruments such as “putting a price on carbon”. Labor’s Department of Climate Change was staffed manly by Treasury people.

But the Libs’ peak disdain for the public service came under Scott Morrison who, upon attaining the top job, told the bureaucrats he wanted no advice from them, just diligent implementation of the policy decisions made by Cabinet.

What gave this bunch of not-so-super men (and the odd woman) the arrogance to believe they could govern wisely without the bureaucrats’ policy advice? Mainly, their ability to fall back on the small army of taxpayer-funded, but unaccountable ministerial staffers, mainly youngsters with political ambitions and the willingness to interpose themselves between the minister and the department.

These young punks, who think they outrank the most senior public servants, are generally big on politics, but weak on policy. Which, you’d have to say, was the Coalition cabinet’s “revealed preference”.

The apotheosis of this decadence was revealed in evidence to the robo-debt royal commission last week. Advice sought from an outside law firm, which found that the government’s cost-cutting scheme was unlawful, was paid for but not passed up the line to the minister – presumably because the bureaucrats judged it would not be welcome.

But in a little-noticed part of a recent speech by Treasurer Jim Chalmers, he left no doubt that, under Labor, Treasury’s advice would be sought, and used to improve the government’s decisions. What’s more, Treasury’s ability to convey its views to the public would be enhanced.

Chalmers noted that, even after the government had dealt with the inflation challenge, “we will have to manage a budget weighed down by persistent structural spending pressures”. Doing this required new thinking and deeper thinking, he said.

“It requires us rebuilding the evidence base for policymaking. Because, to get better, more-forward-looking economic policies, we need better, more-forward-looking policy foundations.”

Chalmers revealed six ways in which he will be “rebuilding the evidence base for policymaking”. One was “putting Treasury back at the centre of climate modelling again”, to build on “the new approach to climate risks, costs and opportunities” revealed in last month’s budget papers.

Second, Treasury’s annual statement on “tax expenditures” would be made “more accessible, more useful analysis of what tax concessions are costing the budget” and their effect on the distribution of income between high and low earners.

Economists have long believed that such “tax expenditures” are equivalent to actual government spending in their effect on the budget balance, and should be subject to just as much critical reassessment as actual spending.

But the Libs didn’t agree. Since taxes are evil, anything you do to reduce them must be a good thing, even if the concessions go to some (usually higher-earning) taxpayers and not others. They sought to play down the tax expenditure statement – which hugely annoys the interest groups receiving concessions on such things as superannuation savings, and the 50 per cent discount on taxing capital gains – by renaming it the “tax benchmark and variations statement”. Not anymore.

The third, even more significant change will be the appointment of an “evaluator-general” to regularly and publicly examine the effectiveness of government spending programs. Many programs don’t do much to achieve their stated objectives, but ministers and their department heads are notoriously reluctant to have them rigorously examined, for fear of embarrassment.

But, as first proposed by economist Dr Nicholas Gruen, such a person and their agency would have similar powers and independence to those of the much-feared Auditor-General. This should work, provided governments couldn’t do what Morrison did to the Auditor-General: cut his funding.

The appointment of an evaluator-general is official Labor policy, and has been championed by the assistant assistant treasurer, Dr Andrew Leigh, whose outstanding economic expertise is negated by his failure to align with any Labor faction.

No doubt Leigh will be keen for the evaluator to make use of the latest in evidence-based decision-making, randomised controlled trials.

The point is that one thing Treasury (and the Finance department) should be hugely knowledgeable about – but aren’t – is what policies work, and what policies don’t. An evaluator-general will fill this vacuum.

Fourth, Treasury will work with Finance Minister and Minister for Women Katy Gallagher to “ensure gender considerations are at the core of our work”, building on last month’s “gender-responsive budgeting”.

Fifth, Treasury will produce Australia’s first “national wellbeing statement” next year, which will be “a hard-headed way to gauge progress by recognising that a robust and resilient economy relies on robust and resilient people and communities”.

And finally, Chalmers will step up production of the Intergenerational Report from five-yearly to three-yearly, in the middle year of each parliamentary term. He promises the document will be “depoliticised”.

It’s true that former treasurer Joe Hockey trashed this exercise by turning it into a blatant attack on his Labor predecessors. It was hard to take subsequent reports seriously, especially when they imposed an artificial cap on tax collections over the next 40 years, while letting government spending run wild.

We need the report to be a much more balanced assessment of future budgetary challenges, not just a Treasury tract on the supposed evils of runaway government spending. We need more acknowledgement of the possible effects of climate change on the budget over the next 40 years – a start to which was made in last month’s budget.

And it would be nice if the report lived up to its name by having much more to say about intergenerational equity issues and trends, such as the effect of ever-rising house prices, and the longer-term consequences of the way the Howard government kept stacking the odds in favour of the old at the expense of the young, particularly favouring the self-proclaimed “self-funded retirees” (who never mention the huge superannuation tax concessions they’ve been given, nor that many of them also get a part-pension).

So, well done, Jim. With better advice and a better “evidence base”, now all Labor needs is the courage to stand up to a few powerful interest groups, including those industries that get the relevant union to plead their case in the new-look Canberra.

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Treasury thinks the unthinkable: yes, intervene in the gas market

If you think economists say crazy things, you’re not alone. Speaking about our soaring cost of living this week, Treasury Secretary Dr Steven Kennedy told a Senate committee that “the solution to high prices is high prices”. But then he said this didn’t apply to the prices of coal and gas.

How could anyone smart enough to get a PhD say such nonsense? He even said – in a speech actually read out by one of his deputies – that this piece of crazy-speak was something economists were “fond of saying”.

It’s true, they are. If they were children, we’d call it attention-seeking behaviour. But when you unpick their little riddle, you learn a lot about why economists are in love with markets and “market forces”, why they’re always banging on about supply and demand, and why (as I’ve said once or twice before) if economists wore T-shirts, what they’d say is “Prices make the world go round”.

At the heart of conventional economics – aka the “neo-classical model” – lies the “price mechanism”. Understand this, and you understand why the thinking of early economists such as Adam Smith and Alfred Marshall is still influential a century or two after their death, and why, of all the people seeking the ears of our politicians, economists get more notice taken of their advice than other professions do.

The secret sauce economists sell is their understanding of how a lot of seemingly big problems go away if you just give the price mechanism time to solve them.

A market is a place or a shop or cyberspace where people come to sell things to other people. The sellers are supplying the item; the buyers are demanding it. The seller sets the price; the buyer accepts it – or sometimes they haggle or hold an auction.

If the price of some item rises, this draws a response from the price mechanism, which is driven by market forces – the interaction of supply on one side and demand on the other.

The price rise sends a signal to buyers and a signal to sellers. The message buyers get is: this stuff’s more expensive, so make sure you’re not wasting any of it.

And see if you can find a substitute for it that’s almost as good but doesn’t cost as much. If you’ve been buying the deluxe, big-brand version, try the house brand.

On the other side, the message to sellers is: since people are paying more for this stuff, produce more of it. “I’m not in this business, but maybe now the price is higher, I should be.” If the price has risen because the firm’s costs have risen, maybe we could find a way to cut those costs, not put our price up and so pinch customers from our competitors.

See where this is going? If customers react to the higher price by buying less, while sellers react by producing more, what’s likely to happen to the price?

If demand for the item falls, and the supply of the item increases, the higher price should come back down.

Saying the solution to high prices is high prices is a tricky way of saying market forces will react to the price rise in a way that, after a while, brings it back down again.

When demand and supply get out of balance, market forces adjust the price up or down until demand and supply are back in balance. The price mechanism has fixed the problem, returning the market to “equilibrium”.

This is the origin of the old economists’ motto: laissez-faire. Leave things alone. Don’t interfere. Interfering with the mechanism will stop it working properly and probably make things worse rather than better.

There’s a huge degree of truth to this simple analysis. At this moment there are thousands of firms and millions of consumers reacting to price changes in the way I’ve just described.

Kennedy admits that “there are many conditions that underpin” this do-nothing policy, but “in most circumstances Treasury would support such an approach”.

There certainly are many simplifying assumptions behind that oversimplified theory. It assumes all buyers and sellers are so small they have no power by themselves to influence the price.

It assumes all buyers and all sellers know all they need to know about the characteristics of the product and the prices at which it’s available. It assumes competition in the market is fierce. And that’s just for openers.

However, Kennedy said, the circumstances of the price shocks caused by the Ukraine war are “different and outside the frame” of Treasury’s usual approach. Such shocks bring government intervention in the coal and gas markets “into scope”. That is, just do it.

“The current gas and thermal coal price increases are leading to unusually high prices and profits for some companies,” he said. “Prices and profits well beyond the usual bounds of investment and profit cycles.

“The same price increases are leading to a reduction in the real incomes of many people, with the most severely affected being lower-income working households.

“The energy price increases are also significantly reducing the profits of many [energy-using] businesses and raising questions about their viability.”

In summary, Kennedy said, the effects of the Ukraine war are leading to a redistribution of income and wealth, and disrupting markets. “The national-interest case for this redistribution is weak, and it is not likely to lead to a more efficient allocation of resources in the longer term,” he said.

(The efficient allocation of resources – land, labour and capital – is the main reason economists usually oppose government intervention in the price mechanism. Markets usually allocate resources most efficiently.)

The government’s policy response to the problem could take many forms, Kennedy said, but with inflation already so high, policymakers “need to be mindful of not contributing further to inflation”.

This suggests that intervening to directly reduce coal and gas prices is more likely to be the best way to go, he concluded.

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One small step for the wellbeing budget, giant leap yet to come

Hey, wasn’t this budget supposed to be Australia’s first “wellbeing” budget? Whatever happened to that? Well, it happened – sort of – but it turned out to be ... underwhelming. Didn’t arouse much interest from the media.

It met the expectations of neither the sceptics nor the true believers. Treasurer Jim Chalmers began talking it up long before he got the job. The treasurer at the time, Josh Frydenberg, thought it was a great joke.

He pictured Chalmers “fresh from his ashram deep in the Himalayas, barefoot, robes flowing, incense burning, beads in one hand, wellbeing budget in the other”.

No robes on budget night. But nor did we see Chalmers make a ringing denunciation of the great god GDP.

No quoting of Bobby Kennedy’s famous words that such measures count “air pollution and cigarette advertising, and ambulances to clear our highways of carnage ... special locks for our doors and the jails for the people who break them [and] the destruction of the redwood and the loss of our natural wonder in chaotic sprawl”.

In short, Kennedy said, “It measures everything except that which makes life worthwhile.”

No, none of that. Nor any condemnation of economic growth or attack on the materialism of our age.

What we got was what Chalmers promised on the day he became treasurer: “It is really important that we measure what matters in our economy in addition to all of the traditional measures. Not instead of, but in addition to. I do want to have better ways to measure progress, and to measure the intergenerational consequences of our policies.”

What we got on budget night was a start to just that. Not a wellbeing budget, but a normal budget with a chapter headed Measuring What Matters.

It kicked off with some stirring rhetoric about how traditional macroeconomic indicators don’t provide a “complete or holistic view of the community’s wellbeing. A broader range of social and environmental factors need to be considered to broaden the conversation about quality of life.”

Then followed a lot of earnest discussion of “frameworks” and other high-level stuff that’s deeply meaningful to bureaucrats, but not the rest of us. It’s not a long chapter, but I had trouble keeping awake – though I may just have been tired at the time.

But don’t get me wrong. Though none of this stuff gets the blood racing, Chalmers is on the right track. It’s just that he’s got a lot further to go before we see anything likely to make much difference.

Let’s start with GDP – gross domestic product. Everything Kennedy said about it is true. Those who say it’s a bad measure of progress or prosperity or wellbeing are right.

But, as every economist will tell you, it was never intended to be. It’s a measure of the value of all the goods and services produced and consumed in Australia over a period, which means it’s also a measure of the total income Australians earn from producing those goods and services.

It counts the cost of the ambulances and tow trucks that attend road accidents, not because accidents are a good thing, but because all the workers involved earn their income by turning up and helping.

If you’d like everyone who wants a job to be able to get one – meaning unemployment is kept low – the managers of the economy need to know what’s happening to GDP to help them achieve that goal.

GDP doesn’t count “the health of our children or the joy of their play” because, apart from the doctors and nurses, the income we earn from that is “psychic”, not something you can bank or spend.

What economists are more reluctant to admit is that their obsession with the ups and downs of GDP – with the purely material aspect of our lives; with getting and spending – has led them to revere GDP as though it measured our wellbeing.

The rest of us have caught the bug from them. This suits the rich and powerful, whose main objective is to get richer and more powerful. They are focused on the purely material, and it makes it easier for them if the rest of us are too.

It doesn’t suit them to have us asking awkward questions about what economic activity is doing to the natural environment – or the climate – why it’s better for so many jobs to be insecure and badly paid, and whether the pace of economic life is extracting an (unmeasured) price from us in stress, anxiety and depression.

So, Chalmers is right. There’s much more to life – to our wellbeing - than just working and spending. If that’s all governments are doing for us, they’re not doing nearly enough.

We put much effort into measuring and thinking about GDP, but need to put a lot more effort into measuring all the other things that affect our lives and how much joy we’re getting.

Business people say that what gets measured gets managed. True – provided politicians take account of those numbers in the decisions they make. Chalmers’ wellbeing budget is still a long way off.

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The cost of living isn't as high as we've been told

So, as we learnt the day after the budget, the cost of living leapt by 7.3 per cent over the past year, right? Wrong. Last week we were told it’s gone up no more than 6.7 per cent for employees, and 6.4 per cent for pensioners and others on benefits.

The 7.3 per cent came from the Australian Bureau of Statistics, and was the rise in the consumer price index over the year to the end of September. The other figures also came from the bureau, and were for the rise in the “living cost index” over the same period for certain types of households.

Why weren’t you told about the second lot? Because the media wanted to avoid confusing you – and because they were better news rather than worse.

Huh? What’s going on? We’re used to using the consumer price index (CPI) as a measure of the cost of living. But the bureau knows it’s not. So, a week later, it always issues its living-cost indexes for key household types – which the media always ignore.

Usually, the differences from the CPI aren’t big enough to worry about. But now they are. Why? Because mortgage interest rates are increasing rapidly. And mortgage interest charges are the main difference between the two measures.

Before late-1998, the CPI measured the housing costs of owner-occupiers according to the interest they paid on their mortgages. But this was changed at the behest of the Reserve Bank, which didn’t want its measure of inflation to go up every time it raised interest rates to get inflation down.

So, since then, the bureau has measured owner-occupiers’ housing costs by taking the price of building a new house or unit. This doesn’t make much sense, since not many people buy a newly built home each quarter. Many of us have never bought a newly built home.

This is why the bureau also calculates separate cost of living indexes, using the same prices as the CPI, but restoring mortgage interest charges, as well as giving the prices different weights to take account of the differing spending patterns of particular household types, such as age pensioners.

New dwelling prices rose by almost 21 per cent over the year to September, meaning they accounted for a quarter of the 7.3 per cent rise in the CPI. By contrast, the mortgage interest charges paid by employee households rose by more than 23 per cent, but contributed only 12 per cent (0.8 percentage points) of the 6.7 per cent rise in their total costs.

Get it? Since mortgage interest charges are a more accurate guide to the costs of owner-occupiers than new-home prices are, the CPI is significantly overstating the rise in the living costs of everyone, from employees to people on social security (and the self-proclaimed “self-funded” retirees, for that matter).

This is a sliver of good news about the extent of cost-of-living pressure on households. It’s better news for people on indexed pensions and benefits: they’ll get what amounts to a small real increase.

But it raises an obvious question: why on earth has the cost of newly built homes shot up by 21 per cent over the past year? After all, this has added hugely to the Reserve Bank’s need to fight inflation by raising interest rates, to the tune of 2.75 percentage points so far.

It’s true the pandemic has caused shortages of imported building materials, but the real blame is down to the economic mangers’ appalling own goal in using grants, tax breaks and cuts in interest rates to rev up the home building industry far beyond its capacity to expand.

It got a huge pipeline of unfilled orders and whacked up its prices, adding no less than a quarter to our soaring inflation rate. Well done, guys.

This raises a less obvious question: federal and state governments were spending unprecedented billions to hold the economy together during the pandemic and its lockdowns. With the official interest rate already down to 0.75 per cent without doing much good, was it really necessary to cut the rate to 0.1 per cent and engage in all that unconventional money creation?

It makes a good case for the new view that, while monetary policy works well when you want to slow demand, it doesn’t work well when you wish to speed it up. Especially when rates are already so low and households already so heavily indebted.

This is something those reviewing the Reserve Bank should be considering.

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Labor will struggle with deficit and debt until it raises taxes

There’s something strange about last week’s federal budget. It reveals remarkably quick progress in getting the budget deficit down to nearly nothing. But then it sees the deficit going back up again. Which shows that, as my former fellow economics editor Tim Colebatch has put it, Rome wasn’t built in one budget.

Let’s look at the figures before explaining how they came about. The previous, Coalition government finally got the budget back to balance in the last full financial year before the arrival of the pandemic, 2018-19.

The government’s big spending and tax breaks in response to COVID’s arrival in the second half of the following year, 2019-20, saw the budget back in deficit to the tune of $85 billion. Next year’s deficit was even higher at $134 billion.

But in the year that ended soon after the change of government in May, 2021-22, the deficit fell to just $32 billion. And in last week’s second go at the budget for this year, 2022-23, the deficit is expected to be little changed at $37 billion – which would be $41 billion less than what Scott Morrison was expecting at the time of the election six months ago.

But the changes in these dollar figures don’t tell us much as comparing the size of the deficit with the size of the economy (nominal gross domestic product) in the same year. Judging it this way allows for the effect of inflation and for growth in the population.

So, relative to GDP, the budget deficit has gone from zero in 2018-19, to 4.3 per cent, then a peak of 6.5 per cent in 2020-21, then crashed down to just 1.4 per cent last financial year. This year’s deficit is now expected to be little changed at 1.5 per cent.

We all know why the deficit blew out the way it did, but why did it come back down so quickly?

Three main reasons. The biggest is that it happened by design. All the pandemic-related measures were temporary. As soon as possible, they were ended.

But also: the rise in world fossil fuel prices caused by the war in Europe produced a huge surge tax collections from our mining companies. Last week’s budget announced the new government’s decision to use almost all of this windfall to reduce the deficit.

And last week we learnt the government had also decided to keep a very tight rein on government spending. It introduced all the new spending programs it promised at the election, but cut back the previous government’s programs to largely cover the cost of the new ones.

Its frugality had one objective: to help the Reserve Bank reduce inflation by first using higher interest rates to reduce people’s demand for goods and services.

Keeping the deficit low for another year has, Treasurer Jim Chalmers said this week, changed the “stance” of fiscal (budgetary) policy to “broadly neutral” - neither expansionary nor contractionary. Which, he’s sure to be hoping, will mean the Reserve has to raise interest rates by less than would have.

Another benefit of his decision not to spend the tax windfall, Chalmers said this week, is that by June next year, the government’s gross debt will be $50 billion lower than it would have been. And, according to Treasury’s calculations, this reduction means a saving of $47 billion on interest payments over the decade to 2033.

Great. Wonderful. Except for the strange bit: two years after this financial year, the budget deficit is expected to have gone back up to $51 billion, or 2 per cent of GDP.

What’s more, the budget’s “medium-term projections” foresee the deficit stuck at about 2 per cent each year – or $50 billion in today’s dollars – for the following eight years to 2032-33.

In the first budget for this year, just before the election, the deficit was projected to have fallen slowly to 0.7 per cent of GDP by 2033. Now, no progress is expected. Which means, of course, that the amount of public debt we end up with will be higher than expected during the election campaign.

The gross public debt is now not expected to reach a plateau, of about 47 per cent of GDP, until the first few years of the 2030s.

So, if the budget deficits last year and this are so much better than we were expecting just seven months ago, why on earth are the last eight years of the medium term now expected to be significantly worse?

Three main reasons. First, because a new actuarial assessment of the future cost of the National Disability Insurance Scheme (NDIS) shows the cost growing much faster than previously thought.

Second, because, with world interest rates having risen so much this year, the interest bill on the public debt is now projected to be much bigger over the coming decade.

Third, because the previous government based its projections on the assumption that the productivity of labour would improve at the quite unrealistic average rate of 1.5 per cent a year, but Chalmers has cut this to a more realistic 1.2 per cent. This change reduces government revenue by more than it reduces government spending.

What this exercise reveals is that the “persistent structural deficit” earlier projections told us to expect, will actually be worse than we were told. The deficit won’t go away but, on present policies, will stay too high every year for as far as the eye can see.

Fortunately, Chalmers freely admits that present policies will have to be changed. “While this budget has begun the critical task of budget repair, further work will be required in future budgets to rebuild fiscal buffers [ready for the next recession] and manage growing cost pressures”.

He repeated this week his view that, as a country, we need to “have a conversation about what we can afford and what we can’t” - his way of breaking it gently that, if the structural deficit is to be removed, taxes will have to rise.

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CONFESSIONS OF AN ECONOCRAT-WATCHER

Talk to ACT Economic Society Annual Dinner, Canberra

I’m very pleased to be invited to talk to you tonight, the biggest and best of the Economic Society’s branches. I should warn you, however, that I’m a follower of the Paddy McGuinness school of public speaking, which holds that it’s no fun talking to a group from any persuasion if you don’t say something to annoy them.

I imagine many of you are econocrats so, before I do, I want to say that I like econocrats. All journalists have “contacts” – people they talk to regularly in their search for stories – or, in my case, for explanations and opinions. In this, the contacts I speak to are overwhelmingly econocrats. I’m too old and proud to speak to ministers’ PR people, and I’ve never been able get much frankness from politicians. I should speak to academic economists more than I do, but these days I get my fill of academia by being an incessant reader of the excellent The Conversation website.

I feel comfortable talking to econocrats, for one main reason: they helped me correct one of the great mistakes of my life. When I was a student at Newcastle Uni in my late teens, I decided that accounting was really interesting, but economics was boring, theoretical rubbish that would be of no use to me in my dream career as a chartered accountant. It wasn’t until I gave up on my accounting career, washed up at the Herald as a graduate cadet, and was advised to become an economic journalist, that I realised I’d got it the wrong way round: it was accounting that was boring, whereas economics was interesting and vitally important in solving the nation’s problems.

My problem was that I’d forgotten most of what I was supposed to have learnt from the three years of economics in my commerce degree. It took me many, many hours on the phone to econocrats in the bureau, the bank, Treasury, the IAC and other agencies to relearn what I was supposed to know. So I’m forever grateful to the econocrats who spent so much of their time helping get me up to speed. I was deeply impressed by their dedication, their selfless desire to educate the public on matters economic by helping educate me. (Now, you may wonder why so many econocrats are willing to speak to me. It’s because they know I’m a columnist, not a reporter. I don’t want to quote them, I want to take those of their opinions I agree with, and make them my own. Opinion writers are in the plagiarism business.)

All this helps explain why I don’t regard myself as an economist, and don’t claim to be one. I used to say I was an accountant pretending to be an economist, but these days I say I’m a journalist who writes about economics. That’s exactly how I see myself, and where my loyalties lie. Because I’m not an economist, I’m not a member of the economists’ union, which means I’m under no fraternal obligation to defend economists and economics against all those terribly ignorant people who keep criticising us and pointing to our failings. I don’t have to believe what everyone in every occupation or industry believes: that if you’re not in our business, no criticism you make of us could possibly have merit.

Being a journalist who writes about economics, my obligation is to my readers. I see my role as similar to a movie critic. I’m an economics critic. I explain what the economists are telling the government to do and why, and then I tell my readers whether I agree with what the economists are saying. To put it more positively, I’ve spent my career trying to figure out how the economy works, then telling my readers what I’ve learnt. This means my views have evolved considerably over the decades. Hopefully, what I say today is closer to the truth than what I used to say.

When top econocrats give a very thoughtful speech about how the economy’s got to its present state, or what we need to do to improve its performance, the press gallery usually riffles through it looking for some particularly newsworthy remark – say, a hint that the cash rate’s about to rise – and then toss it aside. I see it as a big part of my job to rescue the speech from the gallery’s waste-paper basket, and use my column to make sure my readers get the benefit of the top econocrats’ thoughtful explanations and observations. Even when I don’t agree with their policy proposals, I try to give them a fair run before I register my doubts.

Partly because I’m a longstanding exponent of explanatory journalism, I write a lot about economic theory, more than most other economic journalists do. It was many years after I graduated that some economist took the trouble to explain to me the role of theory in our efforts to understand how the world works, to extract some mastery from the seeming chaos around us. About how “models” help us understand the real world by focusing on a few really powerful explanatory variables, and ignoring everything else. The neoclassical model is hugely useful, and hugely powerful in influencing the way economists think about how the economy works – and should work. This is why I keep writing about its assumptions and limitations. I think “behavioural economics” helps ensure our search for a better understanding of how the economy works isn’t held back by those assumptions and limitations.

But my interest in improving on the neoclassical model seems to bring out the defensiveness in academic economists – particularly on Twitter, where what I say is often dismissed as “simply wrong”. But what’s often not understood is that the neoclassical model I care most about is not the one written down in a set of equations, but the one lodged in the heads of econocrats. When I criticise “economists” I’m usually referring to econocrats and other economic practitioners. I care most about what practitioners think and propose because they’re the ones with most influence over policy – the ones with most influence over the economy my readers live in. But academics almost always take “economists” to be referring to them, not to their former students. Their self-absorption is revealing.

I became an economic journalist in 1974, which means I’ve been a professional watcher of the economy – and the econocrats providing economic advice – for almost 50 years. Tonight, I want to reflect on some of the conclusions I’ve reached in that time, the things I’ve learnt, and the way my views have changed. I guess I’ll be accused of being wise after the event, so let me get in first and plead guilty to exactly that. Being wiser after the event isn’t a crime, it’s a virtue. If you don’t learn from your mistakes, you’re not very bright.

When the era of “micro-economic reform” began in the mid-1980s under the influence of “economic rationalism”, I was a strong supporter. Over the 40 years since then, however, I’ve had growing doubts about many of the supposed reforms we’ve made. By now, it’s clear that governments’ enthusiasm for what came to be known as “neo-liberalism” has largely dissipated. Any number of policy changes by Liberal and Labor governments are clearly at odds with the principles of economic rationalism. But it’s not just the politicians who’ve lost their compass. I suspect that many econocrats have lost their John Stone certainty of what’s right and what’s wrong in economic policy.

I think we’re going through a period where econocrats and their fellow travellers are wandering in the wilderness searching for a new program of improvement to be working towards. Economic rationalism 2.0, if you like. Econocrats seem as reluctant as any other profession would be to publicly admit the mixed record of neo-liberalism. But I’m here to say I don’t think econocrats will get their mojo back until they’re willing to admit that many of the things done in the name of micro-economic reform turned out to make matters worse rather than better. We have to learn from our mistakes. I want to propose a couple of principles that should be at the centre of econocrats’ renewed sense of mission.

First, however, we need to think about what went wrong with that great reform push and why. Let’s be clear: the biggest of the reforms were necessary and have worked well: floating the dollar, deregulating the banks, ending import protection, ending centralised wage-fixing and, as Andrew Leigh has reminded us, introducing national competition policy.

The problem has mainly been with privatisation, outsourcing and “contestability” – “reforms” largely motivated by the belief that the provision of services will always be done better by the private sector than the public sector. This is an article of faith for the Liberal Party, but also for too many econocrats. It has succeeded in making the public sector a lot smaller – and very much smaller than it would otherwise have been – but too often this has come at the cost of higher prices (electricity), fewer services and, particularly, lower quality services, delivered by inadequately trained workers. This is true in aged care, child care and employment services. Contracting out to providers in “thin markets” – a Productivity Commission euphemism for pretending there’s a market where none exists - is a big part of the reason for the blowout in the cost of the NDIS. The states’ TAFE systems needed shaking up, but opening up to cherry-picking private providers, plus general cost-cutting, has left us with an utterly inadequate technical education system. Far too many privatisations – particularly in electricity and ports – have involved selling government-owned businesses with pricing power intact, maximising the sale price at the expense of establishing a competitive market.

None of these adverse outcomes were envisaged in the econocrats’ advocacy of these “reforms”. What went wrong when theory was put into practice? One reason is the use of privatisation, and of bureaucrats putting downward pressure contract prices, to reduce “debt and deficit” – which, when you examine it, is about politicians responding to the public’s growing demand for government services, but without asking people to pay for them with higher taxes. This was never going to add up.

But I place some blame on the naivety of our econocrats. They assumed that what works in the textbook would work just as easily in real life. Many econocrats have never worked in the private sector, but are painfully aware of the deficiencies of the public sector. This, plus the neo-classical model’s implicit assumption that markets are rational but governments aren’t, blinded them to the truth that private firms are hugely fallible. Econocrats believed in the profit motive, but didn’t understand its raw, even ruthless power. As we’ve seen from wage theft and the banking royal commission, among other examples, even our biggest, most respectable firms are perfectly capable of breaking the law in their pursuit of profit. Everyone wants to take a bite out of the government. When business people are invited to sell to the government, dollar signs appear in their eyes. They put both hands into the public purse and pull out as much as they can possibly carry away. They think the government’s always an easy touch – and too often they’re right. The bureaucratic regulators of private providers have proved no match for business people on the make.

The biggest reason so many reforms haven’t lived up to their billing, however, is the way the econocrats’ political masters have compromised the economic objectives by adding their own political objectives. Sometimes they’re trying to make the government’s finances look better than they really are. By moving debt off-balance sheet, for instance. But sometimes I suspect that the Liberals, being the party of the private sector, see moving businesses and workers from the public column to the private column as a clear win for their side of politics and loss for their Labor opponents.

There’s much more I could say about the crosses on the economic rationalist report card, but I need to get on with suggesting two key principles I think must be part of any revival of reformist zeal.

First, it’s become an empty cliché to say that policy proposals should be “evidence-based”, but it’s actually our beliefs about how the economy works that need to be more evidence-based. The great advance in academic economics in our time has been the way the information revolution has allowed it to become less theoretical and more empirical. The eternal temptation is to forget that models are just models. They’re not the economy, they’re a cardboard cut-out of the economy. They enlighten us in some circumstances, but mislead us in others. The great project in academia must be to test orthodox theory against the empirical evidence, to see what bits of the theory accurately describe the real world and what bits don’t. The classic example of this is the way empirical evidence has caused economists to change their tune on the role of minimum wages. If there’s one area of the economy where the simple neo-classical model – the one that economists carry in their heads – is an unreliable guide to how the economy works, it’s the labour market. Most econocrats have much to learn from labour economists about how the labour market ticks. Monopsony, for example.

My broader point is that economists who think the neoclassical model they memorised at uni is all they need to give wise advice on policy – whose views on how the economy works haven’t been changed by advances in industrial organisation, asymmetric information, incomplete contracts, behavioural economics and the rest – are setting themselves up for failure. The policies advocated by econocrats have been faith-based rather than empirical-evidence-based.

Second, economic rationalism 2.0 must accept the failure of the smaller-government push. The move to private providers of publicly funded care has not led to any noticeable improvement in the efficiency with which those services are delivered. Where governments have managed to hold down the growing cost of services, this has been achieved by reducing the quantity and particularly the quality of services. Where services have been delivered by for-profit providers, savings from genuine improvements in efficiency have been insufficient to make room for their necessary profit margin. The plain truth is that any savings made by outsourcing services have come simply from side-stepping the good pay rates and conditions of the original workers.

Turning the focus to general government and the budget, the quest for smaller government and its objective, lower taxes, has clearly failed – despite decades of trying. It’s failed because the growth in the public’s demand for more and better government services is inexorable. No government of either colour is prepared to make the big cuts to major spending programs that would make smaller government a reality. Some conservative politicians genuinely believed smaller government was desirable and possible. More of them saw the political attraction of claiming to be pursuing lower taxes while their opponents indulged in “tax and spend”.

Far too many econocrats believed in smaller government and lower taxes as a sure-fire way of increasing economic growth. They focused on the simple theory that taxing any activity always discourages it, while ignoring the absence of empirical evidence that lower company tax leads to increased investment, and lower marginal tax rates encourage work effort. They studiously ignored the evidence that only in the case of secondary earners (mainly mothers) are effective marginal rates likely to affect work effort.

But I think econocrats are guilty of a greater error: their commitment to smaller government – which sort of fits with their day job of using false economies to pare back this year’s embarrassingly high budget deficit – involves pursuing a will-o-the-wisp while ignoring the real challenge. Since big spending on government services is the public’s clearly revealed preference, their job is to use every opportunity to remind the public – not to mention their political masters – that demanding more government spending is fine, provided you’re prepared to pay for it with higher taxes. By omission, econocrats have played along with the delusion that higher taxes are unthinkable – both economically as well as politically – and settled for eternally struggling ineffectively to reduce budget deficits. They should have been doing all they could to stand against the demonisation of taxation for short-term and usually hypocritical political advantage.

Econocrats have spent too long struggling ineffectively to achieve smaller government, while doing little about what should be their real concern: not smaller government, but better government. Government in which the winners from globalisation and other structural change are required through the tax-and-transfer system to compensate the losers. The neglect of fairness toward the losers from micro-economic reform does much to explain why resistance to reform has grown and too many people have become susceptible to populist solutions.

Econocrats need to care more about how, for instance, assistance with housing costs can be more effective and better targeted to those needing it most. Econocrats – and particularly the accountants in Finance – have relied too heavily on crude annual percentage cuts in agencies’ budgets, and too little on building capacity to identify particular areas of waste. It takes no effort or understanding to barrack for small government or big government. What’s hard is knowing how government spending can be efficient and effective. Too often, econocrats have failed to promote and protect spending measures that should be seen as an investment in future cost reduction in return for immediate spending. Too often, the accountants have yielded to the short-term expedient of giving them the chop.

When it comes to regulation, the econocrat profession should be the repository of the nation’s knowledge of what works and what doesn’t, but it’s made little effort to become that. The new government’s commitment to an “evaluator-general” is good news. We need more rigorous evaluation of spending programs, with the results made public. This will always be resisted by ministers and department heads, but that’s all the more reason the econocrats should be unceasing in pushing for it.  Academic health economists worked for many years to build the information base that allowed governments to control their spending on public hospitals more effectively than just giving them 5 per cent more than they got last year. Eventually this “activity-based” funding model was adopted as part of the federal-state hospital agreement. To my knowledge, the econocrats did nothing to support this research effort, and were slow to realise its value.

It’s clear from all the discussion of the fiscal position inherited by the new government that we face a choice between bigger government with higher taxes, and a never-ending struggle with “debt and deficit”. Our econocrats should make sure they’re on the right side.

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If only Labor's wage changes were as bad as the bosses claim

Have you ever wondered why capitalism has survived for several centuries in the advanced economies? How a relative handful of rich families and company executives have been getting richer and more powerful for so long in countries where everyone gets a vote and could, if they chose, insist on something different?

It’s because the capitalists, counselled and coerced by politicians anxious to keep the peace, have made sure that the plebs, punters and ordinary working families have been given enough of the spoils to keep them reasonably content.

I remind you of this because, for 30 or 40 years in America, and now about a decade in Australia, the capitalist system – economists prefer calling it the market system – hasn’t been giving ordinary workers enough to keep them getting better off, while the few people at the top of the tree have been doing better, year after year.

If you wonder why so many Americans voted for a man like Donald Trump, and now delude themselves that he didn’t lose the last election, why the Yanks seem to be rapidly dismantling their democracy, a big part of their discontent is their loss of faith that the economic system is giving them a fair shake.

Fortunately, it’s nothing like that bad in Australia. Not yet, anyway. What’s true is that the average standard of living in Australia today is no better than it was a decade ago – something that hasn’t happened before in the more than 75 years since World War II.

Over the eight years before the pandemic, wages rose barely faster than inflation. We’ve had wage stagnation, now made a lot worse by the supply-chain disruptions of the pandemic, soaring electricity and gas prices caused by Russia’s war, and by the way floods keep wiping out our fruit and vegetable crops.

When Labor went to this year’s federal election promising to “get wages moving”, I think it struck a chord with many voters.

After we ended centralised wage-fixing by the Industrial Relations Commission in the early 1990s, we moved to collective bargaining at the level of the individual enterprise. Workers’ right to strike was hedged about with many requirements and limits.

At the beginning, more than 40 per cent of workers were covered by enterprise agreements. By now, however, some academic experts calculate that the proportion of workers covered by active agreements is down to about 15 per cent.

At the jobs and skills summit in September, all sides agreed that the enterprise bargaining system had broken down. Last week the government introduced its answer to wage stagnation, the Secure Jobs, Better Pay bill.

It would make a host of changes, many of which strengthen existing provisions of the Fair Work Act, and most of which the industrial parties agree would be improvements. It makes job security and gender pay equity explicit goals of the act, prohibits sexual harassment and requirements that workers keep their pay secret, and strengthens the right of workers with family responsibilities to request flexible working hours. More debatably, it abolishes the Australian Building and Construction Commission.

To repair enterprise bargaining, it clarifies the BOOT – better off overall test – requiring that agreements leave no worker worse off. This was the Business Council’s greatest complaint against enterprise agreements.

One reason such agreements now cover so few workers is that they’re expensive and complex for small and middle-size employers to organise. Hence, the proposal to widen the existing provision for “multi-employer bargaining”: workers in similar enterprises allowed to bargain collectively with a number of employers.

This would widen access to enterprise bargaining. It’s aimed particularly at strengthening the bargaining position of women in low-paid jobs in the aged care, childcare and disability care sector.

Ambit claims and exaggerated rhetoric are standard fare in industrial relations, but the cries of fear and outrage coming from the various employer groups are over the top.

It would “create more complexity, more strikes and higher unemployment,” said one. It was “so fatally flawed” it would “emasculate enterprise bargaining”, according to another outfit. It was “seismic” in its impact, claimed a third.

Methinks they doth … I’d be amazed if they actually believe that stuff. They’re probably still adjusting to the shock of having the unions back in the government tent. They know they won’t be able to stop the bill being passed, so they want at least to be seen opposing it with all their voice.

What changing the law won’t change is that the proportion of workers in a union has fallen from 50 per cent to 14 per cent. The small and middle-size businesses we’re talking about have even fewer union members than that.

No union members, no strike. No strike, no big pay rise. In any case, really powerful unions get big pay rises without needing to strike.

This is an attempt to make bargaining provisions that didn’t work last time, work this time. I doubt if these modest changes will do much to “get wages moving” again. More’s the pity. If I’m right, Australia’s capitalism will remain broken.

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Memo RBA board: Time to stop digging in deeper on interest rates

If, as seems likely, the combined might of the advanced economies’ central banks pushes the world into recession, the biggest risk isn’t that they’ll drag us down too, but that our Reserve Bank will raise our own interest rates too far.

That’s the message to us – and everyone else – from the International Monetary Fund’s repeated warnings about the unexpected consequences of “synchronised tighten” by the big economies – America, Europe and, in its own way, China, all jamming on the brakes at the same time.

Synchronised macro-policy shifts are a relatively new problem in our more globalised world economy. Until the global financial crisis of 2008, world recessions tended to roll from one country to the next. Since then, everyone tends to start contracting – or stimulating – at the same time.

When you were stimulating while your trading partners weren’t, much of your stimulus would “leak” to their economies, via your higher imports. But, as we learnt in the fight to counter the Great Recession, when everyone’s stimulating together, your leakage to them is offset by their leakage to you, thus making your stimulus stronger than you were expecting.

The fund’s warning is that we’re now about to learn that the same thing happens in reverse when everyone’s hitting the brakes – budgetary as well as monetary – together. Synchronisation will make your efforts to restrain demand (spending on goods and services) more potent than you were expecting.

So the fund’s message to us is: when you’re judging how high interest rates have to go to get inflation heading back down to the target, err on of side to doing too little.

But there are four other factors saying the Reserve should be wary of pushing rates higher. The first is Treasurer Jim Chalmers’ confirmation in last week’s budget that the “stance” of his fiscal policy has also switched from expansionary to restrictive, and so is now adding to the restraint coming from tighter monetary policy.

Chalmers has cut back the Coalition’s spending programs to make room for Labor’s new spending plans, while “banking” the temporary surge in tax revenue arising from the war-caused jump in world energy prices, and the success of the Coalition’s efforts to return us to full employment.

As a result, the budget deficit has fallen from a peak of $134 billion (equivalent to 6.5 per cent of gross domestic product) in 2020-21, to $32 billion (1.4 per cent) in the year to this June. The present financial year should see that progress largely retained, with the deficit rising only a little.

What’s more, the government’s already acting on its intention to force our greedy gas producers to raise their prices by a lot less than has been assumed in the budget’s inflation forecasts.

Second, the Reserve’s efforts to reduce aggregate (total) demand by using the higher cost of borrowing to reduce domestic demand, will be added to by the other central banks’ efforts to reduce our “net external demand” (exports minus imports).

What’s more, the expected further big fall in house prices will help reduce domestic demand by making home owners feel a lot less well-off than they were (the “wealth effect”).

Third – and this is a big point – the restrictive effect of the Reserve’s higher interest rates will be massively reinforced by the “cost-of-living squeeze” (aka the huge fall in real wages). Comparing the wage price index with the consumer price index, real wages fell by 2 per cent over the year to June 2021, and by an unbelievable 3.5 per cent to June this year.

Now the budget’s predicting a further fall of 2 per cent to June next year, with only the tiniest gain by June 2024.

This is an unprecedented blow to households’ income. It just about guarantees an imminent return to weak consumer spending. And it’s a much bigger blow than the big advanced economies have suffered, suggesting our central bank should be going easier on rate rises than theirs.

The final factor saying the Reserve should be wary of pushing rates higher is “lags”. As top international economist Olivier Blanchard reminded us in a recent Twitter thread, monetary policy affects the inflation rate with a variable delay of maybe six to 18 months.

This says you should stop tightening about a year before you see any hard evidence that inflation has peaked and started falling. Wait for that evidence, and you’re certain to have hit the economy too hard, causing the recession we didn’t have to have.

But to stop tightening before the money market know-alls think you should takes great courage.

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Budget will reduce need for increases in interest rates

When the economy’s needs have switched from stimulus to restraint, it helps to get in new economic managers, who can reverse their predecessors’ direction with zeal rather than embarrassment.

The need for economic policy to change course became clear only during this year’s election campaign, when the Reserve Bank’s concern about rapidly rising inflation prompted it to make the first of many rises in the official interest rate.

So this week’s second go at a budget for the present financial year was needed not just to accommodate a new government with different policies and preferences, but to change the budget’s direction from push-forward, to pull-back.

In just those few months, we changed from “gee, aren’t we roaring along” to “gosh, we better slow down quick”. One moment we’re seeing how low we can get the rate of unemployment, the next we’re jacking up interest rates in a struggle to get inflation down.

A drawback of living in a market economy is that it moves through a “business cycle” of alternating boom and bust. The role of the economic managers is to “stabilise” – or smooth out - the demand for goods and services, cutting off the peaks and filling in the troughs.

The problem with booms is that as demand (spending) starts running ahead of supply (production), it pushes up prices and the inflation rate. The problem with troughs is that as demand falls behind supply, businesses start sacking workers and unemployment rises.

The macro managers use two “instruments” to smooth the cycle’s ups and downs: the budget (“fiscal policy”) and interest rates (“monetary policy”).

With the budget, they increase government spending and cut taxes to add to demand and so reduce unemployment. They cut government spending and increase taxes to reduce demand and so reduce the rate of inflation.

With interest rates, the Reserve Bank cuts them to encourage borrowing and spending by households, so as to reduce unemployment. It increases them to discourage borrowing and spending by households and so reduce inflation.

So, which of the two policy levers should you use?

A new conventional wisdom has emerged among top American academic economists that, because of the two levers’ contrasting strengths and weaknesses – and because interest rates are so much closer to zero than they used to be - you should use fiscal policy to boost demand, but monetary policy to hold it back.

This more discriminating approach has yet to become the accepted wisdom, however. The old wisdom is that monetary policy is the better tool to use for both stimulus and restriction.

The budget’s “automatic stabilisers” (mainly bracket creep and unemployment benefits) should be free to help monetary policy in its “counter-cyclical” role, but discretionary, politician-caused changes in government spending and taxes should be used only in emergencies, such as recessions.

So expansionary fiscal policy did much of the heavy lifting during the pandemic – hence the huge budget deficits and addition to government debt.

But now the Reserve and monetary policy have taken the lead in slowing demand within Australia, so it doesn’t add to the higher prices we’re importing from abroad, thanks to the pandemic-caused supply chain disruptions and the Russian-war-caused leap in fuel prices.

The conventional wisdom also says that, whatever you do, never have the two policy tools pulling in opposite directions rather than together.

If you’re mad enough to have the budget strengthening demand when the independent central bank wants it to weaken, all you do is prompt the bankers to lift interest rates that much higher. This is the “monetary policy reaction function”. One way of saying the central bankers always have the trump card.

Which brings us to this week’s budget redux. How did Treasurer Jim Chalmers play his cards? He did what he thought he could to get the budget deficit as low as possible and so back up monetary policy’s efforts to reduce demand. He’s no doubt hoping this will reduce the need for many more interest-rate increases.

First, Finance Minister Katy Gallagher hacked away at the Morrison government’s new spending programs, so that Labor’s promised new spending could take their place with little net addition to expected government spending over this financial year and the following three.

This wasn’t particularly hard because most of the Coalition’s plans were politically driven, and most hadn’t got going before government changed hands in May.

Second, the same attack on Ukraine that’s causing household electricity and gas bills to rocket has also caused the profits of Australian gas and coal exporters to rocket, along with their company tax bills.

As well, the Coalition’s success in getting employment up and unemployment down has caused a surge in income tax collections.

This huge boost to government revenue isn’t expected to last, so Chalmers has decided to “bank” almost all of it rather than spend it. That is, use it to reduce the budget deficit.

The budget in March expected a budget deficit for the year to this June of $80 billion. Thanks mainly to the tax windfall, it came in at $32 billion, a huge improvement, equivalent to more than 2 per cent of gross domestic product.

The deficit for this year was expected to be $78 billion, but now $37 billion is expected, an improvement of almost 2 per cent of GDP. Next financial year, 2023-24, has gone from $57 billion to $44 billion.

So, the budget deficit is expected to fall continuously from a peak of $134 billion (6.5 per cent of GDP) in 2020-21 to $37 billion (1.5 per cent) this financial year.

That’s enough to convince me the “stance” of fiscal policy is now restrictive. I reckon it’s also enough to convince Reserve Bank governor Dr Philip Lowe that fiscal policy is co-operating in the effort to restrain demand and control inflation.

One small problem. After this year, the deficit’s projected to start drifting back up, and stay at about 2 per cent of GDP until at least 2032-33.

Oh dear. Why? Tell you next week.

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Join the dots: your taxes are heading up, not down

Treasurer Jim Chalmers’ “solid and sensible” budget is not so much good or bad as incomplete. It hints at “hard decisions” to be made but doesn’t make them. It tells us times are tough and getting tougher – which we already knew. What we don’t know is what the government plans to do about it. We were told some things, but one big gap remains.

Chalmers said the budget’s priority was to provide cost-of-living relief. No, not directly – its true focus is on reducing the budget deficit so that the Reserve Bank won’t have to raise interest rates as much to control inflation.

But the big fall in this year’s deficit – made possible by the greater tax revenue from higher export prices – isn’t expected to stop the deficit rising the following year.

And although the budget does include measures that will cut costs for some families – for childcare and prescriptions – these are election promises, not newly announced moves.

The budget’s biggest bad news is that the cost-of-living squeeze is now expected to continue for another two years, with price rises continuing to outpace wage rises. And even when the squeeze stops, real (inflation-adjusted) wages will be a lot lower than they were before the pandemic.

Strangely, the budget’s best news is that the economy’s rate of growth is forecast to slow to just 1.5 per cent in the year to June 2024.

What sounds bad is good when you remember the growing likelihood of a global recession. While most rich economies will go backwards, we should only slow down. Our rate of unemployment is predicted to rise just a bit from its near 50-year low.

World recessions mean we earn less from our exports. They don’t necessarily drag us into recession, as our earlier run of almost 30 years without a recession demonstrates.

Still, a forecast is only a forecast, not a guarantee. The main factor determining if we too end up with negative growth will be whether, in its efforts slow the rate of inflation, the Reserve Bank accidentally raises interest rates more than needed.

This is the BNPL budget – buy now, pay later. Labor bought an easy return to government by promising lots more spending on better government services, while also promising not to increase any taxes – apart from on wicked multinationals – and not to interfere with the already legislated stage three income tax cuts, due in July 2024.

This budget is Labor’s payment for the election it bought. But, as with BNPL schemes, payment comes in four instalments. This is just the first of the four budgets the government expects to deliver before the next election.

Chalmers says it’s “a beginning of the long task of budget repair, not the final destination”.

True. Another way to put it is that this is only the start of his Dance of the Four Veils. In the end, all will be revealed. But right now, we’ve been shown little.

Chalmers keeps saying he wants to “start a conversation” about what services we want government to provide, and how we should pay for them.

A few weeks ago, he got the conversation going by entertaining whether, in the light of all that’s transpired, the stage three tax cuts are still appropriate.

But his boss Anthony Albanese quickly closed the conversation down. No decision had been made to change the cuts, he said firmly.

Since the cuts aren’t due for 20 months, there’s no need for any decision to be announced in this budget, or in next May’s budget. Indeed, any decision could be held off until the third veil is removed in May 2024.

Albanese is waiting and manoeuvring until time and circumstance have convinced us it would be better for the promise to be broken. He’d like people marching the streets with banners demanding the tax cut be dropped.

Those hugely expensive and unfair tax cuts would be so counterproductive to all the problems Chalmers is grappling with, I don’t doubt that at a propitious time, a decision to reduce them will be unveiled.

This will set the stage for the final unveiling of the government’s plan to increase taxes after the next election.

Why am I so sure? Because everything the government is doing and saying points to the need for taxes to go up, not down.

Finance Minister Katy Gallagher has slashed away at the Morrison government’s spending on “rorts and waste”, to make room for Labor’s spending promises – not all of which escape a similar label.

But she has also exposed the way her predecessors were holding back spending on aged care, health, education and much else. Add the National Disability Insurance Scheme, defence, and the interest bill, and you see that strong spending growth in coming years will be unavoidable.

Except for the government’s reticence on tax issues, Chalmers is justified in his repeated claim that this is a “responsible” budget. His more debatable claim is that the budget’s first priority was to provide cost-of-living relief.

That claim came with a heavy qualification: that relief had to be “responsible, not reckless … without adding to inflation”. Yes, the adults are back in charge of the budget.

But the government reticence on tax issues is a big exception to its record on responsible budgeting. The huge increases in gas and electricity prices – mostly collateral damage from Russia’s war on Ukraine – that will do most to continue the cost-of-living squeeze on families this year and next are counterbalanced by the massively increased profits of our exporters of fossil fuel.

Labor’s irresponsible election promise to bind its hands on tax changes has stopped it giving hard-pressed households the consolation of seeing most of those windfall profits taxed, and so returned to other taxpayers for use on more deserving causes.

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Creative destruction: Even pandemics have their upside

There’s nothing new about pandemics. Over the centuries, they’ve killed millions upon millions. But economic historians are discovering they can also have benefits for those who live to tell the tale. Take the Black Death of the 14th century.

In October 1347, ships arrived in Messina, Sicily, carrying Genoese merchants coming from Kaffa in Crimea. They also carried a deadly new disease. Over the next five years, the Black Death spread across Europe and the Middle East, killing between 30 and 50 per cent of the population.

What happened after that is traced in a recent study, The Economic Impact of the Black Death, by three American academics, Remi Jedwab, Noel Johnson and Mark Koyama, and summarised by Timothy Taylor in his popular blog, the Conversable Economist.

The immediate consequences of all the deaths were severe disruptions of agriculture and trade between cities. There were shortages of goods and shortages of workers, so those who did survive had to be paid well. This will ring a bell: with shortages of supply but strong demand, inflation took off.

In England, the Statute of Labourers, passed in 1349, imposed caps on wages. It was highly effective during the 1350s, but less so after that. Similar restrictions were imposed elsewhere in Europe.

Over the next few decades, after economies had adjusted to the worst of the disruptions, the continuing shortage of workers resulted in many rural labourers moving to the cities, which had vacant houses as well as jobs. Farmers had to pay a lot to keep their workers, so real wages had grown substantially by the end of the century.

Since many noblemen had died, the distribution of income became less unequal. Ordinary people could afford better clothing. So, many countries passed “sumptuary” laws under which only the nobility were allowed to wear silk, gold buttons or certain colours. Nor could the punters serve two meat courses at dinner.

Sumptuary laws were an attempt by elites to repress status competition from below.

The authors say the economic effects of the Black Death interacted with changes in social and cultural institutions – accepted beliefs about how people should behave. Serfdom went into decline in Western Europe because of the fewer labourers available.

People became even more inclined to marry later and so have fewer children. Stronger, more cohesive states emerged and the political power of the church was weakened.

It’s widely believed that all these developments played a role in the economic rise of Europe, particularly north-western Europe.

Taylor notes that one of the great puzzles of world economic history is the Great Divergence - the way the economies of Europe began to grow significantly faster than the economies of Asia and the Middle East, which had previously been the world leaders.

This divergence began soon after the Black Death.

“Of course, many factors were at work. But ironically, one contributor seems to have been the disruptions in economic, social and political patterns caused by the Black Death,” he concludes.

Fortunately, advances in medical science mean our pandemic has cost the lives of a much smaller proportion of the population. And believe it or not, advances in economic understanding mean governments have known what to do to limit the economic fallout – even if we didn’t see the inflation coming.

Governments knew to spare no taxpayer expense in funding drug companies to develop effective vaccines and medicines in record time.

One consequence of our greater understanding of what to do may be that this pandemic won’t alter the course of world economic history the way the Black Death did.

Even so, it’s still far too soon to be sure what the wider economic consequences will be. Changing China’s economic future is one possibility. Come back in 50 years and whoever’s doing my job will tell you.

Even at this early stage, however, it’s clear the pandemic has led to changes in our behaviour. Necessity’s been the mother of invention. Or rather, it’s obliged us to get on with exploiting benefits from the digital revolution we’d been hesitating over.

Who knew it was so easy and so attractive for people to work from home – with a fair bit of the saving in commuting time going into working longer. And these days many more of us know the convenience of shopping online – and the downside of sending back clothes that don’t fit.

Doctors were holding back on exploiting the benefits of telehealth, but no more. Prescriptions are now just another thing on your phone. And I doubt if the number of business flights between Sydney and Melbourne will ever recover.

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The knowledge economy is behind the soaring price of land

Over the two centuries and more that people have made a serious study of how the economy works, economists have fallen in and out of love with land. At first, they thought it was at the centre of everything, then they decided it wasn’t terribly important. But the wheel may be turning again. In a major speech last month, the Grattan Institute’s Brendan Coates criticised his profession for its “longstanding intellectual neglect of the economics of land”.

You don’t have to think about housing affordability for long to realise it is not actually the high cost of building a house that’s the problem, it’s the high cost of the land it’s built on.

But why is the cost of land rising much faster than the economy is growing? And why don’t economists take more interest in why this is happening and what we could do about it?

Coates began the annual Henry George Lecture by summarising the history of economists’ waxing and waning interest in land as a resource used to produce goods and services.

The first economists – the Physiocrats – thought of almost nothing other than land, he says. Land was fundamental: agricultural labourers were the source of economic growth, while landlords simply commandeered what the workers produced and flowed it through to the rest of the economy.

The next generation of economists, the “classical” economists of the 18th century, broadened their focus to studying the complex interaction of three “factors of production”: land, labour and (physical) capital.

Adam Smith, a Scotsman known as the father of economics, argued that the “division of labour” – workers specialising in different occupations – and technological innovation were what drove economic growth. But land was still central.

David Ricardo, an English member of parliament, argued that landlords were simply the lucky beneficiaries of land’s natural scarcity (any country has only a fixed amount of it) and its productive capacity, to produce food and fibre and even valuable energy and minerals, Coates says.

And Henry George, the last great classical economist, argued that the rental income enjoyed by landlords must be socialised by taxing the unimproved value of all privately owned land.

Do that, and you wouldn’t need any other taxes. George campaigned hard, but never persuaded any government to follow his advice.

Coates says we “would have done well – possibly much better than we have done – if we’d heeded the lessons of Henry George and paid more attention to the economics of land”.

But in the 19th century the classical economists were replaced by the neo-classical economists, who were a lot less interested in land. And in 1956, the great American economist Robert Solow developed a theory of economic growth, which held that it was improvements in the efficiency with which labour and physical capital (machines and buildings) were combined that drove our standard of living.

The role of land in production - and in inequality - disappeared from the theories economists devised to explain the world, Coates says. Instead, land was treated as just another form of physical capital.

Coates says that “the shifting focus on land in the history of economic thought reflects the changing nature of the economies that economists were trying to explain”.

The Physiocrats observed a world dominated by agriculture. It was obvious that the ownership and use of land determined what got produced, in what quantities. And who got what.

The classical economists watched this world transition through the Industrial Revolution, and the neo-classical economists developed theories for a world that had made that transition.

Economic power started to gravitate towards those who owned capital (whether physical or financial) and away from those who owned land. Agricultural production made way for industrial production.

For most of the 20th century, the neglect of land was of little consequence. More important was the amount of capital invested (to make labour more productive) and the pace of innovation (ditto).

“But as the advanced economies of the world have transitioned again – from manufacturing to services – land is back,” Coates says. Economies powered by intangible capital – how much you know; how much information you can gather – strive or stagnate on the ability of individuals to come together and combine their knowledge and skills.

As any real estate agent will tell you, it’s about “location, location, location”. In Australia, it’s the Grattan Institute that’s done most to help us see that, these days, it’s big cities that drive the economy.

Eighty per cent of the value of all goods and services produced in Australia is generated on just 0.2 per cent of our land. Economic activity is concentrated in CBDs, with the Sydney and Melbourne CBDs accounting for 10 per cent of all economic activity in Australia – more than three times the contribution of agriculture.

This concentration reflects the rise in knowledge-intensive services, clustered together at the hearts of our major cities. The willingness of businesses to pay high rents to locate in the CBDs of our big cities shows the value they gain from access to high-skilled workers and proximity to suppliers, customers and partners.

Similarly, the willingness of workers to pay much higher prices for homes located close to those employment centres shows they, too, see value in being crammed in. Our experience of working from home during the pandemic has changed this a bit – three days in the office rather than five – but not a lot.

All this helps explain why house prices have risen about five times faster than average full-time earnings over the past 25 years. And it means the price of land is a much bigger factor in the economy than it used to be.

It’s leaving existing home owners seemingly much better off, but aspiring home owners much worse off. It’s the product of a clash between the rise of the knowledge economy and our longstanding attitudes towards the taxing and regulation of land.

It should not be beyond the wit of economists to come up with a better approach.

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